Covered Security

A covered security is a security whose adjusted basis a broker is required to track and report to the IRS when it is sold. Section 6045(g)(3)(A) of the Internal Revenue Code defines it as "any specified security acquired on or after the applicable date" that "was acquired through a transaction in the account in which such security is held" or "was transferred to such account from an account in which such security was a covered security, but only if the broker received a statement under section 6045A with respect to the transfer." The regulation adds the mirror term: "The term noncovered security means any specified security that is not a covered security." The distinction was created when Congress required brokers to report basis, and it exists because a broker can only vouch for what it saw: the purchase price of a position bought in its own account after the rules took effect, or a figure handed to it by the previous broker.

The reporting duty is the point of the definition. Under section 6045(g)(2)(A), the broker's return for a covered security "shall include the customer's adjusted basis in such security and whether any gain or loss with respect to such security is long-term or short-term." That is what appears in the basis and holding-period boxes of Form 1099-B, and it is why the IRS can match a taxpayer's Schedule D against the broker's figures for those lots. For a noncovered security the broker reports the sale and the proceeds, and the Form 1099-B instructions let it check box 5 and leave the basis, acquisition-date, wash-sale and holding-period boxes blank. The taxpayer then reports the sale from their own records: the purchase confirmations, the reinvested dividends, the splits and spin-offs. The legal duty to report the gain is identical in both cases; what differs is whether the broker has already told the IRS the answer.

Which securities are covered turns on the "applicable date," and the statute and regulation phase it in by type of security. The regulation's schedule, at 26 CFR 1.6045-1(a)(15), is the one brokers apply:

Two footnotes to the table matter. Stock acquired before 2012 in a dividend reinvestment plan is generally treated as average-basis stock, so it sits on the 2012 line rather than the 2011 line, unless the broker elects out of that treatment. And the statute's own date for digital assets reads "January 1, 2023," while the regulation makes a digital asset covered only where a custodial broker acquired it for the customer on or after January 1, 2026; brokers apply the regulation, and the divergence is explained on the cost basis page.

Status travels, and it travels by paperwork. When a covered security moves from one broker to another, section 6045A requires the transferring institution to give the receiving broker "a written statement" carrying the information the new broker needs to report basis, generally "not later than 15 days after the date of the transfer." A lot that arrives with that statement stays covered; a lot that arrives without one is noncovered in the new account even if it was covered in the old one. Nothing about a sale changes the status either: a covered lot sold in 2040 is still reported with basis, and a noncovered lot sold the same day is still reported without it. Where a customer sells covered shares without telling the broker which lots, the statute directs the broker to report basis "in accordance with the first-in first-out method," except for average-basis-eligible stock, where the broker's own default method applies; the specific identification and average cost pages explain how to override those defaults.

The phrase has a second life that has nothing to do with tax. Section 18(b) of the Securities Act of 1933, 15 U.S.C. 77r(b), lists the "covered securities" that federal law exempts from state registration requirements: nationally traded securities, registered fund shares, securities sold to qualified purchasers as the SEC defines them, and securities sold in certain exempt offerings. A page about state blue sky laws is using the words in that sense, and a page about the qualified purchaser is too. A third, narrower usage, the "covered securities loan" of the SEC's securities-lending transparency rule, is a third thing again. The tax sense is the one a reader meets on a Form 1099-B.

1. Acquisition sets the status. When a security is bought for cash in a brokerage account, the broker records the purchase price and date and checks the acquisition against the applicable date for that type of security. On or after the date, the lot is covered; before it, noncovered.

2. The status follows the lot. If the position is transferred to another broker, the old broker sends a transfer statement within 15 days and the new broker inherits the basis and the covered status. Without the statement, the lot becomes noncovered in the new account.

3. At sale, the broker reports what it knows. For covered lots the Form 1099-B carries proceeds, adjusted basis, acquisition date and the long-term or short-term character, applying first-in first-out unless the customer identified the lots. For noncovered lots it carries proceeds and a checked box 5.

4. The taxpayer completes the picture. Covered lots are generally reported as the broker shows them, with adjustments where the taxpayer's records differ. Noncovered lots require the taxpayer to enter basis and holding period from their own records on Form 8949.

An example of what the split looks like at sale: Ines holds 300 shares of one company, bought in three lots of 100. She paid $20 a share in April 2010, $35 a share in 2013 and $50 a share in 2019, and in 2026 she sells all 300 in one trade at $80 a share for proceeds of $24,000. Her broker must report the sale as two pieces. The 2013 and 2019 lots are covered securities: proceeds of $16,000, reported basis of $8,500, long-term gain of $7,500, all on the Form 1099-B. The 2010 lot is noncovered: the Form 1099-B shows proceeds of $8,000 with box 5 checked and the basis box blank. Ines supplies the $2,000 she paid from her own records, producing a further long-term gain of $6,000, and reports $13,500 of gain in total. Had she lost the 2010 confirmation, the burden of establishing basis would still have been hers, and a basis a taxpayer cannot substantiate can end up treated as zero, taxing the whole $8,000 as gain.

Pros

• For covered lots the broker keeps the basis records, so the taxpayer's Form 8949 largely copies the Form 1099-B.
• The IRS can match broker-reported basis against the return, which reduces the mismatch notices that older, proceeds-only reporting produced.
• Status follows a transfer statement, so moving a covered position between brokers does not lose the basis history.
• The definition is fixed in statute and regulation, so a taxpayer can work out from a lot's acquisition date which side of the line it falls on.

Cons

• Positions acquired before the phase-in dates stay noncovered for life, and the taxpayer carries the burden of proving basis, sometimes decades later.
• A transfer without a transfer statement silently converts a covered lot into a noncovered one.
• Broker-reported basis can still be wrong, for example where a wash sale spans two accounts or a corporate action was misapplied, and the taxpayer remains responsible for the correct figure.
• The same phrase means something unrelated in securities regulation, which trips up readers moving between tax and investing material.